ECONOMIC AND MARKET OUTLOOK 2025

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EXECUTIVE SUMMARY

We head into 2025 with optimism tempered by caution. On balance, the global economy is expected to keep growing, supported by moderating inflation, accommodative central bank policy, and bifurcated yet resilient consumer demand. Yet we must acknowledge that elevated valuations, persistent fiscal imbalances, and potential trade or geopolitical shocks could challenge this cautiously constructive narrative.

Key Themes

• Positive U.S. Growth Outlook. Our base case is generally consistent with consensus that real economic growth in the U.S. should continue to outpace most of the developed world driven by resilient consumer demand, corporate capital expenditures, and a gradual decline in inflation.
• U.S. Government Policy Uncertainties. While the new administration’s focus on tax cuts, deregulation, and fiscal reform could energize growth, investors remain wary of tariffs, spending constraints, and immigration policies that might disrupt both supply chains and labor markets. Beware of the headlines because the details are what really matter.
• Elevated Valuations. Across equities and fixed income, valuations look stretched. Consensus expectations are for more gains, but limited room for error. Tight credit spreads and equity P/E multiples well above historical norms underscore the fragility of the outlook so caution is still warranted. 
• The U.S. Remains Exceptional. The U.S. maintains distinct advantages that set it apart globally, combining strong labor productivity, world-class innovation—especially in AI—and deep capital markets. While fiscal deficits and high market valuations pose concerns, resilient institutions and a dynamic private sector keep the US economy and equities at the forefront relative to the rest of the world.
• Focus on Structural Themes. The progress of artificial intelligence (AI), power infrastructure, and deglobalization remain core investment drivers—though each could stir volatility if adoption lags, policies shift, or supply chains reorganize unexpectedly.

REFLECT, LEARN, & REPEAT

Compared to how we viewed the world twelve months ago, our perspective on the economy and markets broadly has shifted from modestly negative to cautiously positive. The following excerpt from our 2024 Market Outlook summed up our sentiment at the time:

“Soft landings are rare, but even more so in the face of tightening credit conditions like we are experiencing today. Leading economic indicators still suggest the economy will slow further, and the yield curve remains inverted indicating a recession is still in play. Of course, “this time could be different”, but we cringe every time we hear those words said out loud.”

While we still struggle with the concept that “this time could be different”, we also must acknowledge there are structural shifts at play coming out of the pandemic, and zero-interest rate policy, that support the resiliency of the global economy, particularly in the U.S. Those shifts, in addition to some positive surprises, led to generally reliable recession indicators breaking down. From the longest yield curve inversion in history to the most aggressive Fed interest rate hiking cycle ever, the economy held up much better than we could have expected. In fact, it may be the first time in 60 years the Fed has been able to avoid recession while hiking rates due to inflation.   

Regardless, the S&P 500 widely outperformed our tempered expectations in 2024.  Much of the outperformance was again due to exceptional performance from the Magnificent 7 driven by the unexpected emergence of generative artificial intelligence (“AI”). Given the size and scope of these seven companies, the second and third order effects of such performance on various industries and companies in their supply chains was clearly underestimated. With that said, we did begin to see signs of life from other areas of the market over the summer – a positive development that we hope will continue to play out in 2025. 

So, what else did we miss? Of the dozens of reports we reviewed in preparation for 2025, Apollo Global Management summed it up best. Other than the AI boom, they mention two other defining factors that helped the stars align in 2024 and into the new year: 

1. Aggressive U.S. Fiscal Policy more than offset restrictive monetary policy. While Biden era legislation, such as the Inflation Reduction Act and high government spending, are expected to be reformed and lowered under the new administration, potential tax cuts and deregulation may take their place.

2. The U.S economy is less sensitive to interest rate hikes. Relatively benign consumer and business sensitivity to interest rates is a far departure from historical norms. However, years of extremely low rates allowed consumers and businesses to lock in low rates on long-term debt leading to low overall net interest liabilities. The broad effect of higher rates is muted but underneath the surface rising rates continue to have an outsized negative affect on lower income consumers and small to medium sized businesses. 

Worth noting is that we weren’t alone in our tempered outlook in 2024. The range of price targets at the beginning of last year were mostly plus or minus 10%. Even the most bullish forecast last year was nowhere close to what played out. Generally, we view price target forecasting as useless. At best, it provides investors with a general assessment of sentiment from Wall Street’s largest financial institutions. These forecasts are rarely accurate and can be misleading to those who rely on them. The real value is how well investors adjust to new information and surprises as they develop, while remaining focused on the long-term. 

THE ECONOMY

Wall Street strategists generally expect global growth to hover around 2.5 - 3.0% in 2025, reflecting a continued post-pandemic normalization and stable consumer demand in advanced economies. However, a lot can change in a short amount of time. The new administration’s trade stance is generally seen by strategists as a source of global uncertainty. Northern Trust’s “Global Investment Outlook 2025” acknowledges that “tariffs remain a key downside scenario” for global supply chains, potentially hitting Eurozone exporters, North American trade partners, and Chinese manufacturers. Some foresee targeted U.S. tariffs on Chinese goods rising from around 10% to 30%. The potential for aggressive U.S. trade policy is regularly noted by strategists as the wild card in 2025. We tend to agree but take some solace in the fact that the U.S. is relatively self-contained compared to the rest of the world.

The U.S. economy is primarily driven by U.S. consumers. Amazingly consumptions levels in the U.S. are greater than the next six countries combined, while exports are a much lower contributor to economic growth. According to a recent article by Barrons, U.S. exports of goods and services accounted for just 11% of U.S. gross domestic product (GDP) in 2023. At the other end of the spectrum are such nations as the Netherlands, where exports account for 112% of GDP, Germany (48%), and South Korea (44%). On a relative basis, a full-fledged trade war would hurt U.S. consumers but there is evidence that losing access to the U.S. consumer and technology would hurt the rest of the world far more. 

The U.S. economy enters 2025 in an uptrend, underpinned by resilient consumption, a stable labor market, and rising business confidence. For us, the health of the labor market remains a key variable as to the potential for a U.S. recession. We highlighted in past notes our concern that corporate profit margin compression due to several years of above trend inflation could be upon us. Compounded by the labor market balancing out post-pandemic, the risk of faster than expected layoffs as corporations scramble to protect their bottom lines could be the match that set off the gun powder. However, that scenario has yet to playout despite the Fed openly communicating their focus shift from inflation to employment.  Instead, the combination of employment and inflation seems to be at a Goldilocks type of level. The big question is how long that will last.  

After a surprisingly strong 2024, the U.S. consumer is entering 2025 on solid footing but with noticeable splits across income brackets. Aggregate household balance sheets remain generally healthy, with wage growth in excess of inflation hovering around 2%. However, the economic data only tells part of the story.

Younger and lower income consumers have been most affected by high interest rates and inflation. Both cohorts generally carry high debt, invest less, and have less disposable income. At the upper end of the income spectrum, consumers are generally older and have enjoyed a boost from elevated asset prices—particularly in equities and real estate—which contributes to ongoing discretionary spending. While the widening wealth gap in the U.S. and globally is nothing new, recent trends have exasperated the divide. Perhaps this could be a key contributor to political turmoil and the people’s desire for constant party reshuffling around the world. According to research from UBS, for example, the 17.8% top earners own an astonishing 86.9% of total assets in the U.S.

The net impact of the bifurcated economy is without question a big societal problem, but is, for now, less of an issue from an economic perspective. That is because higher earners contribute to a greater proportion of overall consumer spending. Altogether, the U.S. consumer is positioned to maintain spending levels into 2025, buoyed by resilient labor demand and high-income households’ market-driven net worth gains. At the same time, the gap between high earners and lower-income Americans will likely widen if cost pressures remain persistent. Given that consumption is approximately 70% of U.S. economic growth, the health of the consumer is always paramount to maintaining a strong economy.

As forementioned, the health of the labor market and consumer is, for better or worse, reliant on the profitability of corporations. U.S. businesses largely exceeded profit forecasts in 2024, especially in technology and some consumer segments. For 2025, the markets are expecting earnings to rise low-mid-double digits and again in 2026. With that said, we view these forecasts as tentative, given that tax cuts and dollar strength are critical unknown factors. From our perspective, both have the potential to disappoint based on current optimism but for now, corporate profits are hovering near all-time highs as a % to GDP. Regardless, markets may benefit more from better-than-expected GDP and continued labor productivity gains, but it is questionable how much is already priced in. 

We note that sustained rising labor productivity in the U.S., opposed to fiscal or monetary policy expectations, is a core tenant of those who are ultra bullish on the Street. An alternative way to think of labor productivity is workforce productivity. As labor productivity improves, more goods and services are produced for the same amount of work. This effectively provides businesses a cushion against rising labor costs. Theoretically, higher productivity supports improvements in standard of living and lower expected inflation. Since the end of the pandemic, the U.S. has meaningfully outpaced the rest of the world in productivity. 

US POLITICS AND TRUMP POLICY

The new administration has outlined ambitions to broaden tax relief (continuing or expanding 2017’s Tax Cuts and Jobs Act), revamp immigration enforcement, deregulate energy and finance, and realign global trade relationships. Some steps, like revoking certain executive orders and aggressively using executive powers, can move quickly. Others—like passing comprehensive tax legislation or wide-scale budget reform—face possible roadblocks due to a slim Republican majority in Congress.

Many forecasters expect new or extended individual and corporate tax cuts, encouraging near-term investment and supporting corporate profit growth. However, the scope of such legislation might narrow amid deficit concerns. Piper Sandler suggests “the goal is to use the momentum of the election to spur early action,” though actual passage could extend well past the administration’s first 100 days.

We have previously expressed our concerns related to the growing federal budget deficit. The takeaway is that the U.S. has a debt problem that will eventually force the government to make very hard and unpopular decisions. When interest rates were low, high debt levels came with low interest expense. In recent time, rising interest rates have led to a massive increase in interest owed to the tune of nearly $1 trillion a year. At this level the U.S. is paying more on interest than defense or Medicare. 

The newly formed Department of Government Efficiency (DOGE) aims at ambitious spending cuts, but expectations should be tempered. Social security, net interest, Medicare, and defense alone nearly match the figure it would take to become budget neutral. We do expect some impact, but government efficiency is only part of the solution. We also wonder how aggressively downsizing the government at a time when federal spending aided economic growth will affect the markets in the near term. 

The administration’s most immediate actions could involve selectively increasing tariffs on Chinese goods, with 10–20% across-the-board on certain product categories such as electric vehicles. President-elect Trump has also threatened 60% blanket tariffs, but that scenario is seen as less probable and more of a negotiation tactic. Meanwhile, stricter immigration enforcement or deportation campaigns risk tightening labor supply, especially in hospitality, agriculture, and construction. Tariffs and strict immigration policy are seen as inflationary but details such as which industries are most affected, and the pace of implementation will determine the impact. 

MONETARY POLICY AND THE FED

‍The Federal Reserve (Fed) and Fed Chair Jerome Powell has their work cut out for them. Fiscal policy uncertainty, stronger than expected economic growth, and potential pressure from the executive branch increase the risk of a monetary policy error. In December, the Fed cut rates by an additional 25bps as expected. They also released a statement leading market participants to assume a slower rate cut pace in 2025 than originally expected. That was augmented by an inflation forecast that was revised upward from 2.2% to 2.5%. The new information from the Fed sent the market down about 3%, highlighting the fragility of the equity markets trading at premium valuations. Since then, markets have consolidated and have lacked any real direction. 

Perhaps an underappreciated risk that will gain more prominence in 2025 is a reignition of inflation. History tells us that a second wave of inflation is more likely than not. Markets may be underestimating the possibility of an unexpected reversal of interest rate policy by the Fed. Rate cuts may stall if wage inflation or service-sector inflation picks up, or if blanket tariffs on all imports raise costs abruptly. Also, if the U.S. significantly tightens immigration or if deficits lead to excessive liquidity in the system, inflation could re-accelerate, forcing the Fed to reverse its direction and increase rates higher. This scenario would weigh heavily on both bonds and equities similar to what was experienced in 2022. 

EQUITY MARKETS

The global equity markets were once again led by the U.S., and it wasn't close. While strong U.S. economic growth and fiscal stimulus were important factors, the primary difference can be attributed to the AI boom that mostly benefited domestic companies.

At some point the trend will revert, but we haven’t experienced sustained outperformance from the international markets since before the 2008 Great Financial Crisis. Going forward, most global equity forecasts call for mid-single-digit to low double-digit returns, primarily from earnings growth rather than further multiple expansion. 

Europe’s path to outperformance is challenging despite relatively low valuations. The wars along with economic weakness in China have weighed heavily on the region – both of which could continue well into 2025 and beyond. In addition, Europe falls behind from a market structure perspective as investors have favored innovative and capital light technology companies – most of which reside in the U.S. and Asia. One glimmer of hope is provided by the European Central Bank (ECB). They began cutting rates earlier and faster than the Fed for the first time in history. 

Selective emerging markets could surprise in 2025. India, Southeast Asia, and parts of Latin America have the potential to perform well due to improving corporate fundamentals that are supported by supply chain re-routing and domestic-led consumption. 

AI applications, data centers, and crypto currency all require immense amounts of energy. Natural resource exporting countries may benefit as exponential energy consumption forecasts could become a tailwind. In addition, we continue to view China as a favorable risk-reward opportunity in select areas. 

However, a potentially strong dollar and tariffs complicate the outlook for international equity returns for U.S. investors. Despite pockets of opportunity, our focus remains heavily skewed to domestic opportunities. 

In the U.S., the so-called Magnificent 7 were key drivers of S&P 500 performance in 2024. These companies represent a significant proportion of the market and continue to benefit from AI and cloud adoption. After two years of extraordinary returns led by the Magnificent 7, recent equity performance has begun to broaden out into other industries and smaller companies. Our expectation is that this trend could continue, albeit a bumpy ride. That’s not to say the Magnificent 7 won’t continue to perform. They certainly have a lot of momentum underpinned by strong balance sheets, capital spending, and revenue/earnings growth. However, valuations have expanded, and expectations have risen dramatically. 

Recent indicators point to improving participation from more cyclical sectors (e.g., industrials, financials, and consumer discretionary) and from small-mid cap (“SMID”) equities. Strategas Research Partners note that “cyclicals continue to carry the flag of leadership,” especially as investors rotate toward sectors and styles with improving earnings and more modest valuations.

Some of this broadening reflects a healthier backdrop for smaller companies, which for much of the past two years struggled under higher borrowing costs and inflation. Now, as shorter rates look set to fall, SMID companies could find more accessible credit conditions. UBS also suggests that “US SMIDs are poised to benefit from falling interest rates, improved labor availability, and better loan growth.”

Earlier we expressed skepticism around consensus growth forecasts in the low-mid-double-digit range for S&P 500 earnings-per-share (EPS). We also see a path to upside if new fiscal or deregulatory policies bolster corporate profit margins. That alone would push a potential recession further out. That said, high valuations, ongoing policy uncertainty around immigration and tariffs, and rising labor costs could challenge earnings if inflation reacceleration or margin pressures materialize. In other words, there is still much that needs to play out hence our cautious tone. 

According to Goldman Sachs, “US equity valuations are now at levels that have not been exceeded in the post-war era except in the late 1990s. Some of the recent uplift comes on expectations that upcoming policies will boost after-tax earnings. But even adjusting for this, US equity valuations look historically high.” It’s worth noting that Goldman has consistently been one of the biggest bulls on the street for some time, but they recently published their 10-year global equity return forecast at 3% annually. High valuations reinforce the importance of proper risk management and diversification.

FIXED INCOME

Bond markets offer higher absolute yields than seen in years. Investment-grade corporates yield around 4-5%. They offer the potential for mid-single-digit total returns if spreads remain tight and rates decline.

However, spreads are near cyclical lows, leaving little cushion if corporate fundamentals deteriorate. On a relative basis and using investment grade corporate bond yields as a proxy, fixed income yields have matched the S&P 500 earning yield for the first time in 20 years. This has implications for both bonds and equites as an indicator of relative value for less risky bonds compared to stocks. 

A year ago, the consensus call was to go long duration in fixed income. We resisted the urge to “lock in rates” due to our belief that rates could stay higher for longer. That call paid off and we continue to favor shorter maturities in 2025 but are open to adding duration opportunistically. The main question is whether potential inflation or deficit concerns could send long yields higher than expected, making short to intermediate maturities a better bet. 

Fixed income segments outside of traditional investment grade debt, such as high yield bonds (aka junk bonds) and convertible bonds, performed well last year. We stayed away from high yield but benefitted from our convertible exposure. At this point in the cycle, and given very tight spreads, we don’t expect to add high yield until valuations improve. Toward the end of 2024, we added some duration to client portfolios via a modest allocation to mortgage-backed securities (MBS). In our opinion, stable housing fundamentals and the potential for increased lending activity provided a good enough back drop to dip our toes in the asset class. Similar to our approach to equities, we are looking to broaden diversification in our fixed income strategy for our clients in an effort to reduce portfolio risk. 

THEMATIC & PRIVATE ALTERNATIVES STRATEGY

As an investor constructing diversified portfolios with long time horizons, getting the secular themes and sector allocations right can make all the difference. Investing in the right theme allows us to ride the tide opposed to attempting to swim upstream. Of course, not all long-term themes are in favor every year so strong fundamental analysis and conviction are important to stay the course when uncertainty inevitably arises.  

We invest in companies and strategies that stand to benefit along-side several long-term themes. Many of those investments cross over multiple sectors and intersect with multiple attractive themes. Below is a list of some of the themes we are emphasizing in client portfolios for the year ahead.

1. AI Infrastructure & Applications
   The consensus remains that AI is a transformative driver of growth in cloud computing, semiconductor manufacturing, and data centers. Though valuations are lofty for big tech, the sheer volume of AI investment suggests the potential for continued tailwinds. According to Capital Group, Tech giants Amazon, Alphabet, Meta and Microsoft are expected to collectively spend $500 billion over the next three years in a race for dominance. We expect opportunities to emerge beyond semi-conductors but recognize mass consumer adoption may still be years away. 

2. Re-shoring & Industrial Renaissance
   If the Trump administration emphasizes self-sufficiency, domestic manufacturing, industrial automation, and logistics could flourish. Northern Trust, for example, highlights “reshoring can power US industrial growth,” though near-term success hinges on regulatory clarity and stable commodity costs.

3. Utilities & Power Generation
   Rising electricity demand from AI data centers and EVs underpins interest in utilities that can meet new capacity needs. For example, it has been reported that on average a query on ChatGPT requires 10x the amount of energy as a search on Google, but estimates vary widely. Piper Sandler’s “power generation renaissance” remains relevant, with emphasis on nuclear, renewables (despite potential subsidy changes), and grid infrastructure modernization.

4. Deregulation
   Lower regulatory barriers often allow businesses to reallocate capital away from compliance expenses and toward growth-oriented activities like research, expansion, or hiring. For investors, the outcome is a more investment-friendly environment, where strong profitability and easier market entry can spur innovation and potentially uplift equity valuations. Potential deregulation may provide outsized benefits to areas such as financial services, investment banking, and energy.

5. Select Private Alternatives 
   With expensive public markets valuations, interest in private markets remains robust. There are approximately 4,000 publicly traded companies in the U.S., in contrast to well over 25 million private companies. Just from an opportunity perspective, we see value in looking for returns outside of traditional stocks. We also view private alternative strategies as a potential diversification tool to support our primary objective, which is to help our clients achieve their goals. For more information revisit our recent insight on the role of alternatives in modern portfolios. 

Conclusion

While we enter 2025 with a more constructive outlook than a year ago, strong market performance has left valuations high and margins for error small. Despite favorable trends in growth, inflation, and corporate earnings, we remain conscious that high valuations, policy unknowns, and a fragile global backdrop could easily shift the balance. Investors should position with cautious optimism, aware that current tailwinds from consumer spending to productivity gains could quickly reverse if inflation re-accelerates or geopolitical risks intensify. In this environment, quality, diversification, and a focus on managing downside risks remain critical pillars of our portfolio strategy. 

Our fundamental duty is to manage portfolios within the objectives and constraints unique to each client. As was true last year, we have little doubt that unexpected events and surprises will shift the investment narrative in 2025. Yet, by combining disciplined research, thoughtful asset allocation, and a balanced approach to risk and opportunity, we strive to position portfolios to navigate through uncertainty - and to remain resilient no matter how the landscape evolves.

_{References
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KKR Global Macro & Asset Allocation. (2024). Glass Still Half Full: Outlook for 2025.
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Piper Sandler. (December 2024). Outlook 2025: The Big Eco Handoff — Govt to Private.
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UBS. (2024). Year Ahead 2025 Roaring 20s: The Next Stage.
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